CalBusiness

Summer 2007

Power of Ideas

Tearing Down the Walls

Prof. Henry Chesbrough argues that business must open up to foster innovation.

Adjunct Professor Henry Chesbrough's new book, Open Business Models: How to Thrive in the New Innovation Landscape, calls on businesses to break down their walls to foster innovation. In it, he explains why businesses need to open up, distinguishes different types of business models, and outlines how to develop models that best profit from the value of open innovation. The book is colored with timely and relevant examples, describing the success of the iPod and discussing Linux.

Open Business Models builds on his earlier book, Open Innovation: The New Imperative, which argues that open innovation is the new paradigm for organizing and managing research and development. In the book, Chesbrough, Ph.D. 97, argues the advantage of open innovation is that it seeks and nurtures ideas found outside one's own organization and still enables companies to license internally developed intellectual property to other corporations. It examines how companies use technology and market open innovation, and suggests ways to adjust corporate strategy to take advantage of opportunities that arise from such an open system.

Open Business Models has drawn glowing reviews, with BusinessWeek including it on its list of the 10 best innovation and design books of 2006. The following excerpt details Chesbrough's argument that Microsoft should approach its piracy problem with a fresh perspective.

In the earliest phase of the technology, it pays to be very open. Neither you nor others know yet the best use of a particular technology, and no one has an appropriate business model to commercialize any applications either. As the dominant design emerges, tightening the protection for one's ideas becomes very important. In the mature phase, IP management must become more differentiated and segmented, to support different applications of the technology in different uses. In the decline phase, firms can now aggressively harvest the fruits of their earlier investments in IP protection.

To see the benefit of this approach across phases of the [Technology Life Cycle], consider the problem Microsoft is facing with pirated copies of Windows in China. In the US and Europe, Windows has become the dominant PC operating system, and growth in those regions now is quite flat - placing it squarely in the mature phase of the technology life cycle. In China, however, matters are quite different. The rising economic prosperity of the country has created a recent boom in the number of PCs selling in the country, so that in this region, the technology life cycle is transitioning from emerging to growth.

One-size-fits-all thinking would suggest that Microsoft should seek to employ the same protections against software piracy in China that it uses in the United States. This would mean that the company (perhaps in concert with other prominent software companies) should vigorously police the use of its software, and undertake prompt legal action against any and all illegal use, wherever in the world such illegal activities are found.

A more nuanced view of where Windows falls in the TLC suggests a dramatically different approach. In the United States, Microsoft has won the battle for the desktop. Its Windows operating system enjoys a market share in excess of 90%. Even the rival operating system of Linux, from the open source community, poses little real threat to Microsoft's position on the desktop. In China, however, the battle for the desktop is still very much in progress. While Microsoft is in the lead, Linux is making a strong challenge. In fact, the Linux community has signed a deal with the Chinese government to make Linux the default operating system for computers in the Chinese government, and many parts of the Chinese educational system.

In this context, applying Western IP enforcement policies to stem the flood of illegal copies of Windows in China risks winning the battle (to deter and punish IP infringement) while losing the war (to become the dominant standard on the desktop). So long as Linux remains a serious rival for the desktop operating system of choice in China, Microsoft should actually welcome pirated copies of its software. Illegal copies of Windows are free, which helps Microsoft offset the initial cost advantage of "free" open source software. Every copy installed on a Chinese computer that is used by one or more Chinese citizens brings one more person into the Microsoft ecosystem. This strengthens Microsoft's market for third party developers of applications, tools, and other complementary products (some of which are made by Microsoft itself, so that Microsoft can make money on pirated versions of Windows through these other products). More importantly, it denies Linux that next new customer that would similarly strengthen its ecosystem against Windows.

If Microsoft succeeds in discouraging piracy of Windows in China, it is far more likely to drive the user of the pirated software into the Linux camp than it is to drive them into the legion of paid-up users of Windows in China. So long as Linux remains a strategic threat to Windows, this is the exact opposite of what Microsoft's IP management should be trying to accomplish. Microsoft's IP management strategy in China should be focused on securing the victory of Windows on the desktops of all PCs in China. That may require deliberately lax enforcement efforts against pirated copies of Windows for the short and medium term. And there are hints that Microsoft may be doing just that. Only after the Linux threat has been seen off does Microsoft have the luxury of then tightening up the protection of Windows against piracy, as it is now doing in the West.

So Microsoft would be well advised to take a very different approach to managing its IP around Windows in the earlier phase of the TLC in China, when compared to its approach to protecting its IP around Windows in the United States. This suggests that IP management must be driven first and foremost by the business objectives of the company, and not by a legal perspective.

A legal perspective might well be, for example, that lax enforcement of IP in one region sets a bad precedent for IP enforcement in other regions. Another legal view might be to pick an especially egregious case of piracy of Windows in China to set an example for others who might seek to copy Windows illegally themselves. These are worthy points to consider, but are subordinate to the strategic objective of establishing the market position of the default standard operating system in China. Unless the legal team is included in all of the key business and strategic decision-making for Windows in China, the legal specialists, doing their job as best as they know how, might inadvertently sabotage the overall strategy.

Reprinted by permission of Harvard Business School Press. Excerpted from OPEN BUSINESS MODELS: How to Thrive in the New Innovation Landscape by Henry Chesbrough. Copyright 2006 Harvard Business School Press; All Rights Reserved.

"So long as Linux remains a serious rival for the desktop operating system of choice in China, Microsoft should actually welcome pirated copies of its software. Illegal copies of Windows are free, which helps Microsoft offset the initial cost advantage of 'free' open source software."